Essential financial habits for Scottish business owners

After your early-stage business has made some sales, it’s tempting to look at your bank balance and think you’re in a great position.

However, even with healthy customer numbers and revenue, in a small and growing enterprise, things can get bumpy quickly if you don’t implement sound financial management measures.

The key is to keep a continuous cash flow through those difficult early months and years until your business becomes more stable. Without such measures, many enterprises don’t make it to their second or third year.

Having good financial management processes from day one will also make your business more attractive to potential investors and, ultimately, buyers.

Cash-flow forecasting

One reason start-ups fail around years two and three is that they grow too fast and over-trade. These firms don’t have too few customers, they have too many, and lack the cash to fulfill orders and buffer the gap between orders shipped and payments received.

Andrew Shepperd, Director and Co-founder of Entrepreneurs Hub, says: “You can never have too much cash in a start-up, because usually you need more than you initially thought. Raise and save more than you think you need.”

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Proper capitalisation, financial planning, cash-flow forecasting and budgeting are essential to avoid running out of cash, he says.

“Many [start-ups] fall into the trap of looking only at how much they have in the bank,” he says. “It’s healthy to monitor that, but also vital to track your impending liabilities – how much do you owe and when?”

Robust credit control

One of the biggest risks to start-ups is running out of cash while they wait for invoices to be paid. So, a key goal is to minimise days sales outstanding (DSO) – the time between shipping goods and receiving payment. You can do this in many ways, starting with prompt invoicing processes and a robust credit-collection function.

“Alongside prompt invoices, ensure you have the correct payment terms in place with customers, a credit-control team chasing down money, and control over your expenses,” says Andrew.

Try to work with signatories of the Prompt Payment Code, a voluntary commitment for businesses that’s administered by the Office of the Small Business Commissioner. You can also look to arrange with clients for a portion of the total invoice to be paid upfront and a staggered schedule for the remaining payments – especially for long-term or high-value transactions. And look at using different payment methods, such as credit cards, which enable you to get paid almost instantly.

The right cover

Having comprehensive business insurance may feel like added expense, but it’s a key part of building a financially resilient business. Consider protection such as credit insurance against potential bad debts, and key person policies to cover the impact if you lose senior personnel.

“These things can be expensive to implement, but they’re part of your armoury against failure,” says Andrew. “Sales is just one part of building a start-up. You need a structure that supports each sale by maintaining the business until you collect payments, and building it so you are stable enough to repeat that cycle continually. If you don’t know how to do a cash-flow forecast, go to someone who does.”

Limited companies: separate your personal and business finances

Limited-company owners must have a business account and a personal account. They can sometimes still blur the boundaries between their personal and business finances, but it’s a risky practice.

One temptation for a successful start-up owner is to take too much cash out of the business early on. This can weaken it; for example, if you receive a large tax or supplier bill and find you don’t have enough cash to pay it, which can then have knock-on effects that quickly spiral.

Another example of blurring the lines between business and personal finances is using your business account or credit card to pay for personal items. This may not seem like a big deal at the time, but if you don’t document and report this and handle the accounting properly through the director’s loan account, it could come back to haunt you, especially if it becomes a habit.

Any personal costs paid by the company that don’t go through the director’s loan account must be reported as taxable benefits. This ensures the director and the company pay any Income Tax or National Insurance due.

Readers may have heard of personal purchases, such as cars, going through a business.

“If you do this, it could become visible to HMRC, and they will naturally take a dim view of it,” says Andrew.

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Also, during their due diligence, potential investors and buyers will see if you’ve crossed this boundary in previous years’ trading. If the transgression is serious, it could hinder your ability to raise finance or maximise your sale price. It could even scupper a sale completely. So it’s critical to start as you mean to go on by clearly separating your personal and business finances.

“A prospective buyer may also be alarmed at potentially large tax liabilities being moved around the business,” adds Andrew. “They may lose confidence in the purchase and walk away, or insist on demanding, long-term tax warranties, which mean the owner is even more liable for any unplanned tax bills post-transaction. If there’s too much irregularity, they may even feel obliged to notify the authorities.

“An acquisition depends heavily on trust and confidence. If poor practices and tax reporting erode that confidence, the question can arise: ‘What else don’t I know?’ By contrast, maintaining good financial and reporting conduct from the start helps build a strong, attractive business.”